We had no doubt that users would flock to Hulu's excellent content and user-friendly site, but we didn't think the company would make money.

Why not?

Because Hulu's revenue-sharing agreements with its content partners called for it to pass at least 70% of the revenue back to the partners, as well as another 10% to distribution sites. Given the high cost of streaming and bandwidth in those days, as well as the sales and administration costs Hulu had to bear, we thought those economics just wouldn't work.

We also thought that Hulu's ownership structure was basically unworkable: Huge companies that hated each other all using the company to further their own competitive ends, renegotiating deals at Hulu's expense, etc.

So what has happened?

First, Hulu has amassed a big audience, as we expected it might. Second, Hulu's gross revenue has come in strong, which was also not a surprise. Third, Hulu's owners have, for the most part, behaved themselves and let Hulu build a business (not without some serious issues for the future, which we'll discuss in a follow-on post). Fourth, bandwidth costs have dropped rapidly. Fifth, there was one key element of Hulu's economics that we were not aware of that has helped the company control costs.

Of that gross revenue, one source with knowledge of the company's financials estimates that Hulu will keep about 35%-40%. (Hulu's deals with the big content providers yield a 20%-30% of net revenue split to Hulu, but the one-off deals with other content providers sometimes go as high as 50%-50%. So the aggregate net revenue is about 35% of the gross, or $70-$100 million in 2010.)

On the cost side, Hulu has a couple of hundred employees, bandwidth and tech costs, and sales costs and commissions on the revenue that its salesforce sells. The one element of Hulu's network deals we did not appreciate at the outset is that, if a network partner sells an ad, Hulu gets a 30% cut and does not cover ANY of the costs, including the bandwidth costs. This means that on perhaps 50% of the company's revenue, Hulu's 30% split is almost pure profit. This helps the company's profitability significantly.

Rolling up all the costs, a source familiar with Hulu's economics says profitability on ~$70 million of annual net revenue is perfectly reasonable.

That's no guarantee for what happens next. But it's farther than we thought Hulu would ever get.

So, hats off to Jason Kilar and the Hulu team! And an afternoon in the dog house for us.